Market failure Flashcards
What is market failure
Market failure happens when the price mechanism fails to allocate scarce resources efficiently or when the operation of market forces lead to a net social welfare loss
What are the types of market failure
Asymmetric information, Externalities, Market factor immobility, Lack of competition, Missing markets, unstable prices and income inequality
What is a public good
A public good refers to a commodity or service that is made available to all members of a society example street lighting, the sun etc.
What are the characteristics of public goods
Non-excludability, Non rivalry and Non rejectable
What is factor immobility
occurs when it is difficult for factors of production (e.g. labour and capital) to move between different areas of the economy
What is asymmetric information
A term that refers to when one party in a transaction is in possession of more information than the other
How is lack of competition a market failure
Monopoly competition and how they are price takers that can negatively affect the economy
What are missing markets
Missing markets are associated with the difficulties that the free market has in providing pure public goods
How are unstable prices a market failure
Consumers and producers face uncertainty when prices change
What is an externality
Externalities occur when producing or consuming a good cause an impact on third parties not directly related to the transaction, also externalities can either be positive or negative.
What is a de-merit good
A demerit good is defined as a good which can have a negative impact on the consumer
What is a merit good
Merit goods are those goods and services which are positive to the consumer that the government feels that people will under-consume, and which ought to be subsidised or provided free
What does the social welfare system offer
assistance to individuals and families in need such as the NHS
How are public goods (missing markets) a market failure
Pure public goods are non-excludable meaning that they are not able to be provided to one person without others benefiting as a result private sector firms cannot supply this good as they will not gain a profit this is the effect of free-riders causing market failure.
How are merit and de-merit goods a market failure
People who use merit and de-merit goods may not understand the benefits or negative effects of these goods will either over consume or under consume
What are the 4 types of externalities
Negative production externalities – Factory pollution
Positive production externalities – Reforestation
Negative consumer Externalities – Noise pollution, food waste
Positive consumer externalities – Vaccinations
What are private costs
Private costs are internal costs faced by the producer or consumer directly involved in a transaction for example private cost of running a car.
What are external costs
External costs occur when the activity of one agent has a negative effect on the wellbeing of a third party they impose costs on other agents this causes social cost > private cost
What are private benefits
Private benefit, satisfaction that a consumer or producer derives from producing or consuming something
What are social benefits
Social benefits include private benefits but also include external benefits that might occur from production or consumption
What is the marginal private benefit
Marginal private benefit (MPB) is the extra benefit, satisfaction gained by a consumer or producer through consuming or producing one extra unit of a good or service this is used on an externality diagram
What is the marginal private cost
Marginal private cost (MPC) is the internal cost to a producer or consumer from supplying or consuming one extra unit of good or service used on externality diagram
What is the marginal external cost
Marginal external cost (MEC) The cost to third parties from the production/ consumption of an extra unit
How do monopolies contribute to market failure
they limit efficiency, innovation, and healthy competition. They can abuse prices as there is nobody else to compete with. Higher prices can lead to economic welfare loss because it restricts spending and can lead to inequality.
What is imperfect information
Means that merit goods are under consumed and demerit goods are over consumed
How do consumers under consume or over consume merit and demerit goods
Consumers may not know the full personal benefits of merit goods
Consumers may lack information to decide which good or service is right for them
Consumers may not have information on how harmful a demerit good is
Advertising for demerits goods may withhold any health dangers
What is information failure
means merit goods are under provided and demerit goods are overprovided causing market failure and misallocation of resources.
How is income inequality caused
Inequality is caused by wage differentials as generally being in a poor family have limited income and wealth needed to improve their situation. Also discrimination and regressive taxes (poor poorer)
Give an example of factor immobility
land, land is immobile as it maybe only good for one type of agricultural.
How is labour related to factor immobility
If the workers want to switch jobs, as the workers may not want to move house or cant afford to (geographical) also labour in occupation can be immobile as lack of training, education and skills to do a different job and lack of work experience.
What is immobile factors of production
means that there is often a inefficient use of resources – resources often unused or underused, this inefficiency means market failure.
What happens to farmers when there is a sharp drop in prices
leads to a fall in revenue for farmers
Explain the cobweb theory
prices can become stuck in a cycle of ever-increasing volatility. E.g., if prices fall like in the above example. Many farmers will go out of business. Next year supply will fall. This causes price to increase. However, this higher price acts as an incentive for greater supply.
How does the government intervene markets
taxes, subsidies, price controls, market regulation, state of prevision
What are taxes used for in government intervention
Taxes as a type of government intervention is a way to influence how firms and consumers behave in the market.
What are subsidies used for in government intervention
Subsidies can be considered the opposite of tax as it results in a reduction of production costs. Subsidies are pardons or rewards given to firms for producing goods that improve social welfare.
What are the types of price control
Price ceilings (maximum price) & Price floors (Minimum price)
What are price ceiling
In price ceilings, the government sets a maximum price limit that cannot be exceeded for certain commodities. This is particularly helpful in a market where firms have too much control and want to set exorbitant prices.
What is the effect of price ceilings
The main effect of price ceilings is that it keeps the prices of products below the market equilibrium price, rises demand but reduces supply
What are price floors
the government sets a minimum price limit that cannot be exceeded for certain commodities. Therefore, no matter how much competition, firms cannot price their products below a certain amount.
What is the effect of a price floor
When a price floor is set above the equilibrium price, quantity supplied will exceed quantity demanded, and excess supply or surpluses will result.
What is market regulation
Market regulation refers to the rules imposed by the government to change the behaviour of firms and correct market failure.
Effect of market regulation
The main effect of market regulations is better social welfare. For instance, as people under 21 years are prohibited from drinking alcohol, the government ensures that people only drink at a responsible age (alcohol is de-merit good so prevents it)
What is state provision
when a nationalised industry is the main provider of a good or service. Often the case for public goods and merit goods for example NHS.
What is state provision
when a nationalised industry is the main provider of a good or service. Often the case for public goods and merit goods for example NHS.
Effect of state provision
increasing social welfare.
What is government failure
A government failure occurs when a policy intervention leads to a deepening of a market failure or even worse a new failure may arise.
What is government failure
A government failure occurs when a policy intervention leads to a deepening of a market failure or even worse a new failure may arise.
How are policies classed as government failure
Policies that may have damaging long term consequences for the economy / society.
Policies that may be ineffective in meeting aims.
Policies that may cause more losers than winners.
What are the 7 causes of government failure
1) Decisions made in political self interest
2) Low value for money from public sector investment
3) Policy myopia – short termism, ministers change so changes of policy’s
4) Failure arising from lobbying, bribery of politicians to promote companies.
5) Disincentive effects arising from specific policies
6) Information failure
7) Costs of regulations may outweigh the benefits.
What happens to the DS diagram when the government uses a subsidy per unit
The supply will become perfectly inelastic
What are the two types of factor immobility
Geographical immobility – When it is difficult to move from one geographical area to another.
Occupational immobility – difficult to move from one type of work to another.
What are the units/axis used in an externality diagram
Firstly price and quantity of good on axis
On demand line being margin producer/social benefits
On supply line being Margin producer/ social costs
What is a free market economy
A free market is a system of buying and selling goods and services that is not under the control of the government
Why are minimum prices bad
Min price schemes have often failed because they are so expensive for governments
to buy the excess, therefore less spending elsewhere
Minimum prices can create black markets
How do you draw a negative consumption externality diagram
Supply line MSC=MPC
Demand line MSB lower shift than MPB
